Nothing comes easy for the self-employed. Although you may not need to deal with a boss, you face other struggles when you own your business. Fighting for clients with bigger competitors…managing the legal bureaucracy…maintaining a safety net for slow periods.
Here’s another task that is more of a challenge for business owners: getting a mortgage.
At one point in time, the self-employed could file for a “stated income loan.” Some lenders allowed owners to self-report their income, without any backing documentation. This was meant as a way of making it easier for the self-employed…after all, keeping all your paperwork in order is tough! However, this practice was one of the major factors that led to the mortgage crisis of 2007, and have since been severely limited.
It takes more work for the self-employed to get a mortgage, but it’s still very possible. Check out these tips to see what you can do (or should be doing) to make a better case to your lender.
Register and License Your Business
Obviously you wouldn’t choose a mortgage lender that wasn’t licensed. There’s something reassuring about working with any business that is registered…and lenders will definitely feel more confident about providing a mortgage to someone who has official proof their business isn’t an under-the-table operation. A letter from a Certified Public Accountant, showing you have filed self-employed income tax returns for 24 months, goes a long way.
Granted, you are not required to have been in business for two years, but two years of steady employment is a safe benchmark for a mortgage—both for the self-employed and otherwise.
Keep Consummate Records
Keeping track of the numbers is a good habit for any business owner, and it is essential when applying for a mortgage. Sometimes you will only need one year’s worth of documentation, but it’s a safe bet to have two year’s worth ready if needed.
Quickbooks is a great tool for many small business owners, but there are additional benefits to employing an accountant. As seen above, they can serve as a third-party witness to your stability as a business. They can also offer you insight on preparing for a mortgage application. They might not be as knowledgeable as a lender, but they’ve worked within this scenario before.
Lower Your Debt-to-Income Ratio
The Debt-to-Income ratio (DTI) is the biggest hurdle for the self-employed (and exactly where an accountant can give you advice). The main issue many face is that they write off much of their income as a business expense. Taking these deductions can be great from a tax perspective, but by removing it from your taxable income, you also remove it from consideration for your DTI. This makes your true income look much lower, resulting in a much higher DTI…which may derail your mortgage plans. It’s a pain to be taxed for this income, but lowering your number of deductions goes a long way in boosting your DTI.
Another trick is to pay yourself a standard W-2 salary instead of an owner’s draw. This will stabilize your income, which lenders like.
Put Down A Higher Down Payment
This is a trick that works for everyone, but it is especially helpful for the self-employed who face a higher DTI because of deductions. The more you pay upfront for a home, the lower your final debt, and the lower your DTI.
One trick the self-employed may try to use is to utilize funds from a business account as part of a mortgage transaction, or as a “cash gift” to one’s self to be used for a down payment. This is all legal, but your lender will need to determine whether these funds mesh with your reported cash flow. You may need a CPA letter to confirm that these funds do not disrupt reported cash flow of your business model.